Commodity currency outlook p. 6 three-bar intraday forex scalp strategy p.

18

the China revaluation debate: p. 10 and p. 14

GivinG a strateGy a test run p. 34 the robin hood Carry trade: Using the Chinese yuan as a funding currency p. 22

contents
Contributors ...................................................... 4 Global Markets Risk on, risk off: Aussie and Canada ....6
continued gains in the “commodity currencies” depends on whether the global economy can keep rolling. By Currency Trader Staff

Currency Futures Snapshot ................ 27 International Markets ........................... 28 .
n umbers from the global forex, stock, and interest-rate markets.

Global economic calendar ........................ 31
Important dates for currency traders.

On the Money Hail the China float ...................................10
Review the ramifications of china’s decision to allow to yuan to revalue on a limited basis. By Barbara Rockefeller

events .......................................................32
conferences, seminars, and other events.

Key concepts ............................................32 new Products ............................................33

The yuan revaluation situation ................ 14
Forecasts about the impact of a semi-floating yuan are missing the economic mark. By Yinghua Zhu and Marc Chander

Forex Journal ...........................................34
testing out a scalp setup.

Trading Strategies Five-minute forex scalp ............................ 18 .
High winning percentage, modest goals, and favorable entry points help scalp pattern capture profits. By Currency Trader Staff

Looking for an advertiser?
click on the company name for a direct link to the ad in this month’s issue. dbFX esignal FXcM the Futures & Forex expo Your FX trading Room

Advanced Strategies The Robin Hood carry: The yuan as a funding currency .............. 22
the yuan carry trade that started last year triggered a stock and bond bull market around the world. By Howard L. Simons

Questions or comments?
webmaster@currencytradermag.com. 

submit editorial queries or comments to

July 010 • CURRENCY TRADER

ContRIbUtoRs

q howard simons is president of Rosewood Trading Inc. and a strategist for Bianco Research.
A publication of Active trader ®

He writes and speaks frequently on a wide range of economic and financial market issues.

For all subscriber services:
www.currencytradermag.com

editor-in-chief: Mark etzkorn metzkorn@currencytradermag.com managing editor: Molly Goad mgoad@currencytradermag.com Contributing editor: Howard simons

q barbara rockefeller (www.rts-forex.com) is an international economist with a focus on foreign exchange. She has worked as a forecaster, trader, and consultant at Citibank and other financial institutions, and currently publishes two daily reports on foreign exchange. Rockefeller is the author of Technical Analysis for Dummies (For Dummies, 2004), 24/7 Trading Around the Clock, Around the World (John Wiley & Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and How to Invest Internationally, published in Japan in 1999. A book tentatively titled How to Trade FX is in the works. Rockefeller is on the board of directors of a large European hedge fund. q marc Chandler (marc@terrak.com) is the head of global foreign exchange strategies at Brown Brothers Harriman and an associate professor at New York University’s School of Continuing and Professional Studies. Chandler has spent more than 20 years analyzing, writing, and speaking about global capital markets. He has worked for several consulting firms and banks as well as a hedge fund in the early 1990s. Chandler appears regularly on CNBC and Bloomberg Television. He is the author of Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange (Bloomberg Press, 2009). q yinghua Zhu is a financial research analyst

Contributing writers: barbara Rockefeller, Marc Chandler, Chris Peters editorial assistant and webmaster: Kesha Green kgreen@currencytradermag.com

President: Phil Dorman pdorman@currencytradermag.com Publisher, ad sales: bob Dorman bdorman@currencytradermag.com Classified ad sales: Mark seger seger@currencytradermag.com

Volume 7, Issue 7. Currency trader is published monthly by techInfo, Inc., 161 n. Clark st., suite 4915, Chicago, IL 60601. Copyright © 2010 techInfo, Inc. All rights reserved. Information in this publication may not be stored or reproduced in any form without written permission from the publisher. the information in Currency trader magazine is intended for educational purposes only. It is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. traders are advised to do their own research and testing to determine the validity of a trading idea. trading and investing carry a high level of risk. Past performance does not guarantee future results.

specializing in commodity and emerging-market investment at a New York-based money management firm. She is a graduate of the University of Chicago, where she received a master’s degree in statistics.

4

July 2010 • CURRENCY TRADER

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GLobAL MARKets

risk on, risk off: Aussie and Canada
Enthusiasm for “commodity currencies” dependent on sustained global economic recovery.
By CurrEnCy TradEr STaff

“Risk on, risk off” may be the mantra for the darlings of the FX world in recent months — the Australian dollar (AUD) and the Canadian dollar (CAD). Bolstered by solid underlying economic growth fundamentals, higher interest rates in Australia, and a new tightening cycle in Canada, these country’s currencies have been favorites among forex traders. Both Canada and Australia are major commodity exporters which has adds to their luster because of expectations (however shaky) of continued global economic recovery. However, since late April when U.S. equities topped out, both the Aussie and Canadian dollar, or “loonie” have

FIGURE 1: CURRENCIES AND STOCKS

posted overall losses. From April 23 through June 24 the U.S. dollar gained 6.91 percent vs. the Aussie dollar and 4.48 percent vs. the Canadian dollar (Figure 1). That data “shows how excessively badly these currencies perform against others when risk is ‘off,’” says Brian Dolan, chief currency strategist at Forex.com. However, the early June rebound in stocks helped flick risk switch back to the on position. “The Aussie dollar has recovered quite smartly from its slide in May, with investors snapping it up before a test of .8000,” says Sean Callow, senior currency strategist at Westpac Institutional Bank in Sydney. “Global risk appetite has improved, most importantly in equities. The daily correlation of percentage changes between AUD/USD and the S&P 500 was a solid 0.70 in the first quarter 2010 but rose to a very tight 0.84 in the second quarter. So Wall Street is vital for the Australia dollar at the moment.” Let’s shift away from forex action for a moment and examine the underlying fundamentals of the Australian and Canadian economies, which are the basis for the attractiveness of their currencies during times of global financial risk appetite.

up down under

From April 23 through June 24 the U.S. dollar gained 6.91 percent vs. the Aussie dollar (top) and 4.48 percent vs. the Canadian dollar (middle).

Bottom line, the Aussie economy is in better shape than most other developed nations. “I see GDP growth accelerating to 3.0 percent in 2010 from 1.3 percent in 2009,” says Stephen Roberts, chief economist Australia at Nomura Australia. Matt Robinson, senior economist at
July 2010 • CURRENCY TRADER

6

Moody’s Analytics Australia has a similar outlook, targeting Australia’s 2010 GDP growth at 2.7 percent. “The Australian economy has outperformed most of its industrialized country peers over the past two years,” he says. “Buoyed by a mix of policy stimulus, solid fundamentals, emerging market export demand, and surprisingly resilient confidence, Australia avoided recession and quickly returned towards its trend growth rate.” A key factor behind this strength is Australia’s export picture. “We expect a major acceleration in export growth over the next 12 months mostly because of the strong growth recoveries in Australia’s major export markets in Asia,” Roberts says. Australia exports several important raw commodities, including coal, iron ore, gold, crude oil, natural gas, aluminium, beef, and wheat. “Commodity export volumes are growing at the moment after a cooling during the global recession,” says Gavin Stacey, fixed income strategist at Barclay’s Capital. “Even more important is the fact that the price of Australia’s commodities are going up rapidly. This gives Australia a massive income boost, which in turn spurs growth elsewhere in the economy.” Australia’s strong ties to Asia — arguably the fastestgrowing economic region in the world — are pivotal to its growth outlook. “More than 70 percent of Australia’s exports are destined for Asia, 55 percent to just four markets – China, Japan, South Korea and India,” Roberts notes. “The two biggest exports to Asia are coal and iron ore, but an increasingly big export item is liquefied natural gas.” Buttressing a robust commodity export position is Australia’s solid fiscal condition. “Australia has a relatively enviable fiscal situation; modest budget deficit and minimal net debt,” Moody’s Robinson notes. In stark contrast to the U.S., UK, and some other Western countries, Australia managed to avoid digging itself into too big a hole during the financial crisis. “Until 2008-09 Australia had run budget surpluses for a decade and had run net government debt down to zero,” Roberts says. “Post global financial crisis fiscal spending has pushed the budget position into a relatively small deficit, and the worst is already over. The budget position is expected to return to surplus within three years and net government debt is likely to peak on our forecasts around 7 percent of GDP, before declining back to zero before 2020.” Barclay’s Capital’s Stacey has an even more optimistic view on the Aussie budget. “Australia has a very low government net debt level,” he says, noting the “balance is forecast to return to surplus in 2012-13. Once again strong
CURRENCY TRADER • July 2010

commodity prices lie at the heart of the strong fiscal position. In essence, strong commodity prices boost mining profits, which lifts government revenues.”

aussie rate advantage

Another factor supporting the Aussie in the FX arena is high interest rates. With an official central bank lending rate of 4.5 percent, the Aussie dollar boasts bullish rate differentials vs. New Zealand dollar (2.75 percent), the British pound (0.5 percent), Canadian dollar (0.5 percent), Euro (1 percent), and the U.S. dollar (0.25 percent). While the Reserve Bank of Australia (RBA) is currently assumed to be taking a break from its recent tightening moves, analysts see additional rate hikes not to far in the future. “I expect another set of three 25-basis-point rate hikes between November 2010 and February 2011,” Nomura’s Roberts says. Moody’s Robinson sees the possibility of a rate hike at the August RBA meeting but thinks November is more likely, adding that Moody’s Analytics expects the official rate to move to 5.25 percent by mid 2011.

Canada keeps its bearings

Although it posted a 2.6-percent GDP decline in 2009, Moody’s Economy.com forecasts a strong +3.5-percent GDP reading for 2010. “The Canadian economy looks good,” says Nick Bennenbroek, head of currency strategy at Wells Fargo. “The economy is growing and getting steady job growth each and every month. They don’t have the same budget problems the U.S., U.K., or Europe have.” The absence of a housing bubble and bust and sustained consumer strength have helped keep Canada on an even keel. “Consumer spending has been very hot,” says Jimmy Jean, economist at Moody’s Economy.com, who refers to Canada as one of the better-performing developed nations. “They haven’t had the pressures on household wealth and consumer credit, which are still prevalent here in the U.S. Canada is well positioned and is ahead of the pack, especially with Europe looking at the possibility of another recession.” Jean also says strong banking positions have helped support Canada’s rebound. “Banks in Canada haven’t been affected by the recession,” he explains. “They remain well funded and they didn’t restrict credit to consumers.” Home buying and consumer spending related to new homes has bolstered growth. First quarter 2010 data shows consumer spending grew by 4.5 percent, which is “very strong” according to Jean.
7

GLobAL MARKets

FIGURE 2: WEEKLY AUSSIE DOLLAR

The 2009 rally took the AUD/USD pair close to its July 2008 all-time high of .9849, but that level might be out of reach for the foreseeable future, according to some analysts.

FIGURE 3: LONG-TERM LOONIE

Jean explains. And the U.S. simply isn’t growing as strongly as the Asian region soaking up the majority of Australian exports. “We have seen higher [Canadian] exports of commodities, especially since the beginning of 2010, but it hasn’t been the primary driver of recovery,” Jean says. “Nearly all those exports are absorbed by the U.S. and it hasn’t been a big bonanza.” Another similarity to Australia is Canada’s moderate debt situation. Although Canada fell into a deficit in 2008 and 2009 because of stimulus spending, that deficit came “after 12 years of fiscal surplus,” notes Moody’s Jean. Generally known as a government focused on fiscal prudence, Canada “came out with a budget in February to close the deficit by 2015,” Jean adds. “No one is looking for their debt to become unsustainable anytime soon,” Bryson says.

An exceptionally strong a 6.1-percent GDP growth rate in the first quarter of 2010 was one of the factors behind the Bank of Canada’s (BOC) decision to initiate a rate-hike cycle in early June. The BOC bumped up its central bank lending rate by 0.25 percent to 0.50 percent. “It shows the economy is heading toward self-sustaining growth so they are starting to remove unconventional policy measures” Jean says of the strong first quarter growth. He forecasts additional rate hikes this year that could “drive the rate to 1.50 percent by yearend.” Wells Fargo’s Bryson agrees with Despite its losses vs. the U.S. dollar during the financial crisis, the Canadian that forecast. “We see another 100 basis dollar is currently closer to its November 2007 generational high than its March 2009 crisis low. points [in rate hikes] this year to take the rate to 1.50 percent,” he says. Looking out toward the end of 2011, Overall, by sidestepping the roots of the global recesBryson sees additional Canadian tightening that will evension, Canada was able to rebound faster than the U.S. “Domestically, they never had much of a housing bubble tually bring the benchmark rate up to 3.50 percent. “Obviously, rate hikes will be supportive to the and their banks weren’t really exposed to sub-prime Canadian dollar,” he adds. loans,” explains Jay Bryson, global economist at Wells Fargo. “Going forward we see relatively strong growth at Currency action 3.5 percent GDP in 2010.” The daily chart of Aussie/U.S. dollar pair reveals that after Also, Canada, like Australia, is a major commodity a hefty sell-off from mid-April into mid-June, the Aussie exporter, including crude oil, iron ore, aluminum, and dollar has begun to strengthen again. gold. Figure 2 shows the AUD/USD rally in late 2009 took the However, the destination of Canada’s exports is differpair within spitting distance of the July 2008 high of 0.9849. ent. “75 to 80 percent of Canadian exports go to the U.S.,”
8 July 2010 • CURRENCY TRADER

boC rate hikes

That was the highest level for the Aussie dollar vs. the buck since it began floating in December 1983, says David Forrester, vice president global FX strategy at Barclay’s. However, Forrester says his firm does not expect a test of that high, for two reasons. “We expect a stronger U.S. dollar going forward as U.S. economic data surprise to the upside and eventually lead the Fed to start raising rates in the first half of 2011,” he says. “This will help erode the AUD’s interest-rate advantage and also withdraw some of the global liquidity underwriting all risky assets, including the AUD.” The second reason is related to an expected cool-down in Asia. “We expect emerging-market Asia to continue to gradually tighten policy this year, which again will withdraw some of the global liquidity underwriting the AUD and prevent the high global inflation that led to AUD moving to a post-float high in 2008 given its attraction as an inflation hedge” Forrester says. Westpac’s Callow sees an outright shorting opportunity in the Aussie. “The RBA is in an extended pause in its tightening cycle, and given the risks to Chinese growth, too much good news seems to be priced into AUD/USD in the .8700-.8800 area,” he says. “We would look to go short in this region, with a stop loss around 0.8900, targeting 0.77 over the third quarter.” Turning to the Canadian dollar, Wells Fargo’s Bennenbroek saw upside potential for the Canadian loonie based on interest-rate differentials. “We see the Fed steady and the ECB steady, and we think the BOC will be raising rates before the end of the year,” he says. The USD/CAD pair, which in April fell to its lowest level in nearly a year before rebounding to around 1.08 in May, was again turning back toward parity (1.00) in late June (Figure 4). Bennenbroek targeted gains in the Canadian dollar/U.S. dollar to “parity, but there is potential to go beyond that,” he says.

be wary

Dolan points to the potential for the global recovery to falter in the months ahead, and notes the dampening effect this would have on the “commodity currencies.” “People are bullish on these [currencies], because people are bullish on the global recovery view,” he says. “The global recovery is likely to be stalling. These are higherbeta currencies for the risk. When risk is on and the outlook is positive, these currencies will tend to appreciate to a greater extent than other non-dollar currencies.” On the flip side, however, when risk appetite decreases these currencies can rack up outsized losses relative to the dollar, he adds. Overall, Dolan admits “there are a lot of reasons to buy” these two currencies but underscores that they “are all dependent on the view for global recovery.” “I think we are at the tipping point into the end of July,” he says. “Things are likely to only become more negative. I think the global recovery is extremely imperiled and the markets have only begun to start repricing that. Everybody’s bullish on these currencies, which is another reason that downside might be underestimated,” Dolan concludes.›

CURRENCY TRADER • July 2010

9

On tHe MoneY on the Money

hail the China float
China’s decision to allow to yuan to float on a limited basis has implications for the fX market and the global economy.
By BarBara roCkEfEllEr

Is China running the global macro show these days? The evidence is strong China has more influence than it’s getting credit for, and it’s not doing a bad job, either. But we can barely stand to think of the idea of China running the show because the Chinese approach is one of judgment, management, and top-down control rather than free-market principles. Just ahead of the G20 summit in Toronto in late June, China announced it would allow a more flexible yuan exchange rate from the dollar peg instituted in July 2008. Before that, from August 2005 to July 2008, the yuan was in a managed float that resulted in a 20-percent appreciation against the dollar (Figure 1). As with all artificially set rates, a chart like this is of no

use to a technical analyst. We might suggest the scope of the first revaluation is likely to be repeated, but such an assertion would have to be a matter of faith rather than evidence. Conditions are different now than in 2005. Not only are conditions different within China, the entire world of international finance has been transformed — by everything from the Bear Stearns and Lehman Brothers failures to the sub-prime and European sovereign-debt crises. And therein lies the explanation for the Chinese abandoning the managed float and returning to a fixed-dollar peg: as 2008 progressed, they lost confidence in the soundness of Western and particularly American institutions to deal effectively and quickly with crisis. Figure 2 shows the yuan/dollar from March 2008, when Bear Stearns failed, to the FIGURE 1: CHINESE YUAN (WEEKLY) July restoration of the dollar peg. We need to revisit this ancient history to understand what is happening today in the FX and other markets. On the surface, the Chinese appear to be caving in to Western demands for a revaluation to reduce trade imbalances. Despite their repeated warnings that they accept no outside interference and will act only on their own timetable, China was concerned about the threat of a face-losing unfavorable mention at the G20 meeting, not to mention a U.S. Senate tariff bill. But the decision to re-float the yuan is actually a vote of confidence in Western governments and financial institutions. That it signals a spirit of cooperativeness and suits domestic Chinese priorities (such as promoting consumption During its “managed float” from August 2005 to July 2008, the yuan and tempering hot-money flows) is appreciated 20 percent vs. the dollar. secondary. The decision has far-reach-

10

July 2010 • CURRENCY TRADER

ing consequences for intermarket analysis and for the aged float saw the heavy hand of the state from Day dollar. 1 (June 21). First there was a big move, then on Day 2, To see how events might unfold, we need to instead of the morning fixing at a set percentage change go back to 2008 again. The Fed had already cut from the previous day’s fix price, the central banks set the rates (by 50 basis points) in September 2007 and rate at the previous day’s close. The day after that, Chinese November 2007 (by 25 bp), but on January 22, 2008 banks became heavy dollar buyers, presumably as a form and again on March 18, 2008, it cut rates by an of hidden state intervention, to prove the managed float “emergency” 75 bp for a total of 2.25 percent. In April it cut again by the FIGURE 2: CHINESE YUAN 2008 more usual 25 bp. This series of rate cuts was taken by the markets as a signal the Fed was willing to throw the dollar under the bus in order to keep the financial sector liquid and functioning, and thus fend off recession. This was the period when hedge funds and other supposedly sophisticated investors decided oil was a hedge against the falling dollar. This never made much sense from an economic perspective; if the U.S. was heading into recession, surely demand for oil would fall and prices should follow suit. The dollar index was crashing during 2006-2007, and oil started to move inversely, with more momentum near end-2007 (Figure 3). This The July 2008 restoration of the dollar peg halted the yuan’s continued strange correlation was halted and appreciation. reversed, for a while, around the same time as China re-pegged the FIGURE 3: DOLLAR INDEx vS. OIL yuan in July 2008. Speculators, including banks, lost a lot of money when oil failed to keep rallying to $200/barrel, as forecast, and instead stopped at a high of $147.27 on Sept. 11, 2008. In fact, the yuan peg coincided with the end of the stock market free-fall and drop in 10-year Treasury yields, as well as the end of the oil bubble (Figure 4). We don’t usually attribute all these events to the single act of the Chinese re-pegging the yuan, but the Chinese assert their decision was for the greater good of the global financial system, and we cannot say they are wrong.

Fast forward to summer 2010

China’s decision to re-engage in a man-

The inverse relation between oil (red) and the dollar (black) halted and reversed (for a while) around the same time as China re-pegged the yuan in July 2008.

CURRENCY TRADER • July 2010

11

on tHe MoneY

was not a one-way street. On any day the yuan may vary as much as 0.05 percent, but not every day. Speculators are on notice not only of a two-way street, but also that the government is market-savvy and can change its practices at will.

Manipulating your currency via a managed float is a very different thing from manipulating other markets with a diverse set of players, such as Euro/dollar, oil and gold. And yet, on the first trading day after the weekend announcement of the float, the Euro/dollar opened higher but closed near its low, and proceeded to fall for the next two days — in the FIGURE 4: 2008 COMpARISON midst of a corrective up move (Figure 5). Commentators for the most part noted China’s announcement of the resumption of the float was Euro-negative, as though this was the most natural and logical thing in the world. But it’s not natural and logical. Why should the Euro automatically fall? By the time of the 2008 yuan peg to the dollar, the yuan had already appreciated against the Euro by about 15 percent. Perhaps analysts assumed the yuan would be an equilibrating agent — and yet the sums that go through the tightly controlled yuan market are tiny compared to the overall size of the Euro/dollar trade. Nobody knows how much the yuan will rise against the currency basket, The yuan (green) peg coincided with the end of the stock market free-fall which does indeed include the Euro as (black), a drop in 10-year Treasury yields (blue), and the end of the oil bubble well as the dollar, but current thinking (red). is that it will be less than the 2005-2008 move and possibly as little as the nondeliverable forwards suggest, or 2-3 FIGURE 5: EURO/DOLLAR percent per year. All the work is not yet in, but even if it’s a reasonable 10 percent, that’s not going to change the global imbalance by much. But maybe it doesn’t need to be changed by much; a change at the margin can be critical. The other effect of the China float is the encouragement of risk appetite, which has the perverse effect of raising the price of oil and other commodities, surely not a goal of the Chinese. Equities, as of the week ending after the announcement, are not embracing the Chinese move as an “all-clear,” but they can be a bit slow to see the forest for the trees. Right now the forest looks gloomy. The U.S. continues to show signs of persistent recessionary tendencies, On the first trading day after the announcement of the float, the Euro/dollar pair including housing sales down despite opened higher but closed near its low, and fell for the next two days — in the the lowest mortgage rates in 60 years, midst of a corrective up move. a distinct lack of inflationary pressure
July 2010 • CURRENCY TRADER

12

FIGURE 6: SHANGHAI COMpOSITE vS. THE S&p 500
and, as of the Federal Open Market Committee meeting in late June, U.S. rates on hold for an indefinite “extended period.” First-quarter GDP was reported at only 2.7 percent in the final estimate, down more than expected from the first estimate and down a lot from Q4 at 5.6 percent, if a whole lot better than -6.4 percent in Q1 the year before. Deleveraging is still taking place slowly and banks are still not lending, preferring instead to borrow at nearly no cost and park the money in safe, if lowyielding, government paper while they re-build capital. Net-net, the China float does the U.S. three favors, not only by the vote of confidence and some trade equilibraChinese stocks (black) have sold off significantly over the past several months. tion that will push exports and exportindustry jobs, but also optimism that the world’s second largest consumer of oil (and vast stockglobal change is possible and a rise in piles), China can potentially have a big effect on day-torisk appetite. As timing goes, the Chinese picked a really day demand. As the world’s largest gold producer, it can good point in the cycle to demonstrate confidence in the influence the price of gold if it starts heading for $1,500 West and promote risk appetite — with little risk of being and $2,000, signifying fear. And as the second-largest accused of starting a forest fire. By normalizing conditions holder of U.S. government paper it can, as we have already and reducing uncertainty about the currency component, seen several times, influence yield simply by repeating it if a managed float can be called “normal,” they also are will continue to hold and to buy, even if the reason is not setting the stage for a recovery in their own stock index, particularly pro-U.S. (It has no choice — the U.S. has the beset by numerous structural problems and down in bearonly large bond market.) market territory that may be just leveling near the end of It’s not that China will or should manipulate global marJune (Figure 6). kets, but make no mistake, it could if it wanted to. China the currency effect has a mistrust of the free market and prefers control. The The near-term effect of the China float on the dollar should mistrust is defensible. History shows whole generations be relatively negative. With U.S. interest rates so low, the can lose their savings and trust in government, a very big dollar is a funding currency for carry trades into more risk for what is essentially a new regime. The communist risky and glamorous assets, including BRIC equities. regime may date back to 1949 but the partial embrace of Longer-term, to the degree trade does become less free markets, dating from 1979 but accelerating after 2002, unbalanced, the ugly U.S. deficit may become less of a is relatively new. It has paid off handsomely, too. Why risk millstone around the dollar’s neck. The question then it? becomes when the Fed will raise rates. After the downbeat A new era may be about to begin in which prices are a June policy meeting, forecasters pushed out their first-hike lot less free, whether from the heavy hand of regulation or date to end 2011 and some even to 2012. Relative interest state interference. The interesting thing about such a trend, rates are not the only factor determining exchange rates if it develops, is that artificially set rates are not sustainable these days, but they are still a powerful one. That implies once the market decides against the false levels. The most a weak dollar for a very long time, but it also implies low famous case is the UK, where Britain saw its artificially bond yields, with the 10-year yield breaking the 3-percent pegged currency get thrown out of European Exchange “floor,” but the bright side of that is lowered funding costs Rate Mechanism (ERM) in 1992 after extreme pressure at a time when bond vigilantes are complaining about the from speculators, including Mr. Soros, with great financial nearly Grecian level of U.S. government debt. and economic dislocations both before and after. The quesWhat if revived risk appetite takes oil back to $140, or tion becomes whether a government that likes control can some other unintended consequence develops? China has demonstrate restraint.› more than one ace — the pegging ace — up its sleeve. As For information on the author, see p. 4.
CURRENCY TRADER • July 2010 13

On The MOney

The yuan revaluation situation
Economic realities in China make the much-debated yuan exchange rate less of an issue than many traders think.

By yinghua Zhu and MarC ChandlEr

The Russian despot Vladimir Lenin was a big fan of Frederick Taylor, an American whose scientific management principles revolutionized the labor process by boosting output, albeit often at the cost of worker dehumanization. Taylorism is not about capitalism per se, it is about efficiency, and apparently good communists can respect that. As Taylorism was adopted by the Soviet Union, so too, it appears, “Fordism” may be coming to China. Fordism refers to a type of political economy that recognizes, despite great disparities in power between workers and owners/management, workers need to earn high enough wages to purchase the goods that are being created in order to complete the production cycle.

FIGURE 1: EURO/YUAN

The financial impact of the Euro’s decline over the past six months has prompted European officials to dial back their calls for Chinese yuan appreciation (Figure 1). While the U.S. Treasury appears to be embracing a multilateral effort (e.g., via the IMF and G20), many in the U.S. congress are preparing to escalate their case for yuan appreciation, perhaps (if it is not too cynical) as the November midterm elections approach. Unfortunately, the focus on bilateral exchange rates makes for poor economics and poor policy and investment strategy, even if it plays well in Peoria. The large U.S. trade deficit with China (and its larger trade deficit with the rest of the world) is not simply a function of exchange rates, but is rather a result of investment, savings, consumption patterns, and corporate strategies, which include the division of labor brought about by globalization.

Wages, not exchange rates

In addition to falling hard against the dollar, the Euro has declined significantly vs. the Chinese yuan over the past six months. European officials have dialed down their calls for Chinese yuan appreciation in light of the Euro’s decline.
Source: ADVFN

Although many pundits refer to China as “factory of the world,” it might better described as the “assembler of the world.” While last year China was the world’s biggest exporter, it was also one of the world’s biggest importers. China does not simply import raw materials and commodities; it also imports parts and semi-finished goods, which it then assembles. Those imported raw materials and commodities are largely invoiced in U.S. dollars, as are the parts and semi-finished goods. The cost of these inputs is estimated to be about 25 percent of the price of the finished good. Another quarter of the price can come from the valueadded in the assembly work, which is the only part that is sensitive to the value
July 2010 • CURRENCY TRADER

14

of the yuan. The other 50 percent of the price is incurred locally in the U.S. for storage, shipping, and marketing. Of course, each of those middlemen also earns a profit. The fact that only a small part of the price of the Chinese-made goods is impacted by the value of the yuan means that nearly any reasonable currency appreciation will be insufficient to balance the accounts. Some U.S. politicians like to cite extreme estimates that the yuan is undervalued by as much as 40 percent vs. the dollar. But the discrepancy between U.S. and Chinese manufacturing wages represents an even more profound gap. Chinese manufacturing wages are about 3 percent of manufacturing wages in the U.S. The impact of a 40-percent appreciation of the yuan on the price of a Chinese good would be limited to the increased cost of the value-added component of that good—that is, the wages of the Chinese manufacturing worker. Everything else being equal, it would raise the price of a Chinese-made good by 10 percent. However, Chinese manufacturing wages would still be only 4.2 percent of U.S. wages, and the imbalance would remain. A sharp appreciation of the yuan would also reduce import prices, and therefore likely offset the impact on wages. Experiences in other countries, such as Japan and Germany in 1970s, suggest a strengthening currency will make the life of many low-cost manufacturers difficult, and in these circumstances whether a country can upgrade its value-added would be a key factor to determine its future competitiveness.

Lessons of the 2005 yuan revaluation

Commodities that rely on Chinese demand will ultimately benefit from eventual yuan revaluation. The 21-percent of appreciation in the yuan from July 2005 to July 2008 provides clues to how commodities may be affected this time around (Figure 2). Like then, the move will probably be gradual and take place over months and years rather than days. Commodity prices were somewhat encouraged by the moderately stronger yuan, but the primary driver of the 100-percent upward movement during that period was a Chinese economy firing on both domestic and export cylinders. This time around, exports may play a smaller role in the economy and domestic consumption may have a larger role. Chinese domestic consumption is also commodity intensive (i.e., products such as automobiles and white goods). A revalued yuan will only enhance domestic purchasing power. There was a speculation in 2005 that Chinese purchases of U.S. Treasuries would dwindle as its need to intervene decreased. However, net Treasury purchases actually rose between 2005 and 2008. Trade surpluses
CURRENCY TRADER • July 2010 15

On The MOney

FIGURE 2: DOLLAR/YUAN

most in the domestic A-share market after China’s July 2005 yuan revaluation, because the move reduced the cost of raw materials such as fuel oil and pulp, and increased the ability of domestic consumers to take on higher costs. Companies with dollar-denominated debt also benefited after the 2005 revaluation. Since the yuan’s first appreciation against the USD that year, there have been three major periods of currency movement: 1) July 2005-May 2006, when the yuan appreciated slightly and the MSCI China index rose about 2.7 percent annually; 2) June 2006-July The dollar/yuan pair shifted slightly out of its straitjacket after China 2008, when yuan appreciation accelerannounced in mid-June it planned to let the yuan resume floating in a limited ated and the MSCI China index rose range. 2.3-percent per month on average; and Source: ADVFN 3) August 2008 to mid-June 2010, when yuan appreciation stopped and the MSCI also rose dramatically during this window, which might China index was flat. It appears yuan appreciation may have been the primary catalyst for the increased Treasury have some positive impact on Chinese equities, perhaps purchases. attracting even more hot money. Revaluation may be a positive for the Chinese A-share Revaluation will also support the currencies of Emerging market (the country’s domestic-only equity market) Asia and Australia, economies that are closely linked to because it makes stock valuations appear more attractive China. Forty-nine percent of China’s imports came from in foreign currency terms and will aid Chinese companies Emerging Asia, followed by Japan, with 13 percent. China by boosting domestic purchasing power. Raw material has been Emerging Asia’s biggest trading partner over importers, airlines, and paper producers benefited the the past few years and a gradual yuan appreciation will further boost the country’s purchasing power. China is South Korea’s largest trade partner, accounting for a much China says it will loosen reins larger portion of Korean imports and exports than the U.S., In late June China’s central bank signaled it would make Europe, or Japan. China is not only the biggest source of the yuan more flexible. Although the move was univerMalaysia’s imports but also one of the major destinations sally embraced, what the U.S. (and many others) mean for its exports, behind only the U.S., the EU, Japan, and by flexible is different than what China means. The U.S. Singapore. In addition, China is Argentina’s second-largest means the Chinese government should stop depresstrade partner, topped only by Brazil. ing the yuan so the currency can appreciate accordMore flexible yuan policy could also mean the yuan ingly. China seems to mean two-way movement within a could fall. Most people have assumed a non-dollar-pegged relatively narrow band. The 0.5-percent band that China yuan would mean a higher yuan, which, all else being allows the yuan to fluctuate vs. the dollar’s reference rate equal, would reduce the Chinese trade surplus with the is not being changed. U.S. (and is what the Americans want). On the other hand, China’s move succeeded in stealing some of the thunif China enters a period of more consistent trade deficits, it der from its critics at the Toronto G20 meeting the weekwould not be surprising if the yuan actually falls. Much to end of June 25, but the resulting pace and magnitude of the surprise of many observers and economists, China did the yuan’s appreciation is far from clear. The 12-month import more than it exported in March 2010. › non-deliverable forward market implies a little more than
2-percent appreciation over the next year which, if roughly accurate, is not very meaningful in terms of trade and capital flows.
For information on the authors, see p. 4. To read an extended version of this article, which analyzes China’s labor situation and the implications of a revalued yuan, see the September issue of Active Trader magazine, available in August.

16

July 2010 • CURRENCY TRADER

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tRADInG stRAteGIes

Five-minute forex scalp
favorable winning percentage and aggressive entry points help scalp pattern capture modest profits.
By CurrEnCy TradEr STaff

Although intraday trading lures many market players who are reluctant to make long-term trade commitments, it’s not an easy path to profits. For starters, traders must overcome the high commission and slippage costs of active trading, they can’t make big mistakes that will wipe out multiple small gains, and they also have to be able to sit in front of the screen all day or have an automated execution setup. And they’re often competing with highly sophisticated and well-funded algorithmic trading firms. This all might lead one to wonder whether there are any scalping opportunities left in the markets for retail traders. There might be, but traders should be realistic about what they can accomplish. The following analysis of a short-side scalping setup offers some potential insights into the issues traders will confront regarding trade entry and timing on a very short-term time frame.

intraday setup

Figure 1 highlights four examples of a three-bar pattern based on five-minute bars in the Euro/USD pair (EUR/ USD): two consecutive bars that close in the upper 25-percent of the bar’s range followed by a bar that makes a high at least .0004 higher than the previous bar but closes in the lower half of the bar’s range and below the previous close: 1. 2. 3. 4. 5. (close[1]-low[1])/(high[1]-low[1]) >= .75 (close[2]-low[2])/(high[2]-low[2]) >= .75 High[0] - High[1] >= .0004 close[0] < close[1] (close[0]-low[0])/(high[0]-low[0]) <= .5

Where 0, 1, and 2 refer to the most recent bar, one bar ago, and two bars ago, respectively. The various parameters can certainly be modified or optimized, although none of the ones used here are; they are simply based on observation of five-minute bars from June 3 to June 24. Figure 1 shows price dropped at least modestly for several bars after each highlighted bar, with the exception of the one that occurred around 9:10 a.m. Also, no research was conducted to test this pattern or a similar formation on the long side of the market. Table 1 shows the EUR/USD’s average performance from the close of the final bar of the pattern to the closes of the subsequent 12 five-minute bars for the June 3-June 24 period. Two results are shown for each bar interval: one for all 82 patterns, and another for patterns that occurred between midnight and 5 p.m. ET (“00-17 ET”), which encompasses the London and New York trading sessions (59 total). This was done simply to see if there was a notable difference between performance in peak and non-peak trading

FIGURE 1: SHORT SCALp SETUp 1

The pattern goes short after two five-minute bars close strongly, and are then followed by a bar that trades higher but closes weakly.
Source: TradeStation

18

Month 2010 • CURRENCY TRADER July

hours for this currency pair. The table also shows the total native trading sessions of both components of the EUR/ profit (sum) that would have been captured by exiting the USD pair. Table 2 shows the ratio of the cumulative gains trades at each given bar, and the overall performance for for all trades and the midnight-5-p.m. trades, with both all one- to 12-bar close-to-close moves for the analysis peri- groups being adjusted for their number of trades. A numod. Figure 2 graphs the pattern’s bar-to-bar performance, ber above 1 means the “all trades” group was more profitand highlights its high winning percentage, especially in able per-entry than the midnight-5 p.m. group; a number the first few bars. below 1 means the opposite. After bar 3, the midnight-5 Considering it is unoptimized and provides no context — no informaFIGURE 2: SETUp 1 BAR-BY-BAR tion about the immediately preceding price action or the prevailing trend, for example — the pattern shows evidence it was able to identify intraday weakness in the EUR/USD pair. Although an average -1 or -2 pip move might seem hardly worth the effort, it is more noteworthy in light of the EUR/USD pair’s upside bias during the period (most five-minute intervals had an average close-to-close gain of five or six pips). The cumulative gains show exiting the trades automatically at each bar’s close was profitable, not accounting for commissions. (The figures in the sum row are negative because they represent short trades and price declines.) Also, the subset of trades in the midnight to 5 p.m. ET period were more profitable, on average, than all trades The setup’s winning percentage, which was especially high in the first few bars, combined — which is what we’d expect never fell below 65 percent. given this period encompasses the

TABLE 1: SCALp SETUp 1 ANALYSIS
Bar 1 All Avg. Sum Overall Bar 0.0000 -0.0025 0.0006 7 All Avg. Sum Overall -0.0001 -0.0044 0.0006 00-17 et -0.0001 -0.0032 00-17 et 0.0000 -0.0008 2 All -0.0001 -0.0091 0.0006 8 All -0.0002 -0.0124 0.0006 00-17 et -0.0002 -0.0104 00-17 et -0.0001 -0.0064 3 All -0.0001 -0.0045 0.0006 9 All -0.0002 -0.0151 0.0006 00-17 et -0.0002 -0.0111 00-17 et 0.0000 -0.0024 4 All -0.0002 -0.0135 0.0006 10 All -0.0002 -0.0183 0.0005 00-17 et -0.0002 -0.0108 00-17 et -0.0002 -0.0116 5 All -0.0002 -0.0157 0.0006 11 All -0.0002 -0.0136 0.0005 00-17 et -0.0001 -0.0071 00-17 et -0.0002 -0.0131 6 All -0.0001 -0.0104 0.0006 12 All -0.0002 -0.0131 0.0005 00-17 et -0.0002 -0.0131 00-17 et -0.0002 -0.0088

The moves were small, but the setup bucked the EUR/USD’s bullish bias during the analysis period.

CURRENCY TRADER • July 2010

19

tRADInG stRAteGIes
TABLE 2: pRIMETIME ADvANTAGE?
bar 1 bar 2 bar 3 bar 4 bar 5 bar 6 bar 7 bar 8 bar 9 bar 10 bar 11 bar 12 2.33 1.02 1.33 0.84 0.86 0.85 0.98 0.86 0.98 1.22 1.38 0.96

FIGURE 3: SHORT SCALp SETUp 2
p.m. group was more productive than the all trades group, with the exception of bars 10 and 11. (The lower cumulative profits for the midnight-5 p.m. group at each interval are simply a function of its smaller number of trades.) Overall, though, it might be wise to question the practicality of this setup, given the maximum accumulated profit was 183 pips (exiting on the close of bar 10), before commissions. Let’s see if there’s any way to extract more potential from the pattern.

From bar 4 to bar 12 trades executed between midnight and 5 p.m. ET had a relative advantage over all trades for all intervals bars 10 and 11.

The second short setup enters .0006 above the high of the second consecutive bar that closes in the upper 25 percent of the bar’s range. In both cases the entry points were higher than the third bar’s close.
Source: TradeStation

selling into strength

Like many patterns of this type, execution is triggered by evidence of the reversal of the recent price momentum. In this case, the upside momentum of two bars that close strongly is reversed by a third bar that closes weakly. It might be psychologically comfortable to wait for the confirmation of the third bar’s weak close, but doing so

means the market has already moved lower by the time the trade is executed. Although this might be relatively unimportant to a pattern triggering a trade that might last several days or weeks (or even hours), it can mean the difference between winning and losing when attempting to scalp the market to extract a handful of ticks. It would be

TABLE 3: SCALp SETUp 2 ANALYSIS
Bar 1 All Setup 2 -0.0003 Overall Win % Bar 0.0006 74.07% 7 All Setup 2 -0.0007 Overall Win % 0.0006 70.37% 65.22% 00-17 et -0.0009 69.57% 00-17 et -0.0006 2 All -0.0006 0.0006 85.19% 8 All -0.0008 0.0006 66.67% 65.22% 00-17 et -0.0010 82.61% 00-17 et -0.0006 3 All -0.0009 0.0006 81.48% 9 All -0.0009 0.0006 66.67% 60.87% 00-17 et -0.0009 78.26% 00-17 et -0.0009 4 All -0.0007 0.0006 77.78% 10 All -0.0007 0.0005 66.67% 65.22% 00-17 et -0.0008 78.26% 00-17 et -0.0007 5 All -0.0010 0.0006 74.07% 11 All -0.0006 0.0005 59.26% 60.87% 00-17 et -0.0009 73.91% 00-17 et -0.0011 6 All -0.0008 0.0006 70.37% 12 All -0.0009 0.0005 62.96% 56.52% 00-17 et -0.0009 69.57% 00-17 et -0.0010

The second scalp setup was much more profitable than the first on a net basis, despite triggering only 33 percent as often.

20

July 2010 • CURRENCY TRADER

much more advantageous to enter when the market is still rising. Further analysis showed the lower-close component — which was the result of visual chart inspection — was more or less superfluous. In fact, by requiring the second and third bar’s to exceed their preceding bars’ highs by a certain amount, it was possible to enter a certain amount above the second bar’s high — rather than at the third bar’s close — and enhance the pattern’s profitability (in the context of a modest scalp approach, of course) without sacrificing much of its reliability. The modified pattern rules are: 1. 2. 3. 4. (close[1]-low[1])/(high[1]-low[1]) >= .75 (close[2]-low[2])/(high[2]-low[2]) >= .75 High[0] - High[1] >= 0.0006 High[1]>High[2]+0.0004,

This variation removes the current bar’s close from the picture, and instead requires the current bar’s high to be at least .0006 above the previous bar’s high, and that bar’s high must to be more than .0004 above the preceding high. Again, these parameters are unoptimized; no effort was made to find better-performing settings. Figure 3 shows two representative trades. Notice the dashes marking the entry points on the left sides of these bars are well above the closing prices. The first setup, which also triggered a trade at the 9:30 a.m. bar, would have entered seven ticks lower on the close and would have been in the red for most of the next 10 minutes. By entering short at the current bar .0006 above the trades occurred in the previous bar’s high (High[1]), this scalp pattern sells into “prime time” period. strength as it still unfolding rather than entering lower on a “confirming” lower close. Although this pattern triggered only 27 times durFIGURE 4: SETUp 2 BAR-BY-BAR ing the analysis window, Table 3 shows it was much more profitable than the initial setup, both on an average-trade basis and cumulatively. Figure 4 graphs the pattern’s performance. Again, the winning percentage was very high (above 70 percent through bar 7), and the median trade profit peaked at bar 5. Adjusted for the number of trades, the difference in performance is even more noticeable. This setup was cumulatively more profitable than the first despite far fewer trades. The ratio the second pattern’s trade-adjusted profitability was five to 31 times larger than the initial pattern’s from bars 1 to 3, after which it tapered off to the 3 to 4 range. (It was smaller only at bars 11 and 12.) Finally, Table 4 shows there was The second scalp pattern’s winning percentage was very high, especially at little difference between the midnightbars 1-3, which were all 80 percent or higher. 5 p.m. trades and all trades — mostly because 23 of the 27 trades occurred
CURRENCY TRADER • July 2010

in the “prime time” period. The ratio of trade-adjusted cumulative profits flitted above and below 1.00, with the midnight-5 p.m. results operating at a slight advantage through bar 6 and a slight disadvantage after. (The negative result at bar 12 is the result of the cumulative net gain posted by the second pattern at this interval.) There’s not a lot of room for error in any short-term intraday trading technique. TABLE 4: pEAK Large losses must be avoided AND OFF-pEAK and a relatively high winning percentage must be maintained 0.94 bar 1 to keep profits flowing. Also, 0.97 bar 2 traders do not have the luxury 1.00 bar 3 of waiting for a confirming move before entering position; 1.16 bar 4 more often than not, doing so 0.98 bar 5 will mean the move is over 0.91 bar 6 before you can capitalize on 1.07 bar 7 it. Most of all, traders must 0.90 bar 8 reconcile themselves to trading 1.07 bar 9 large position sizes to make the 1.05 bar 10 small point gains of such set2.19 bar 11 ups worthwhile (see the Forex -0.52 bar 12 Trade Journal, for example). Selling into strength or buying There was little weakness that is still in effect difference between the increases the odds of capturing midnight-5 p.m. trades more of a correction or reverand all trades — mostly sal.› because 23 of the 27

21

ADVAnCeD stRAteGIes tRADInG stRAteGIes

the robin hood carry: The yuan as a funding currency
The opening of the yuan carry trade after June 2009 led to a liquidity-fueled global stock and bond bull market.
By howard l. SiMonS

Carry trades have been part of the global financial and economic landscape for the entirety of the floating exchangerate era. As long as one country’s interest rates are less than another country’s interest rates, the temptation to borrow in the former and lend in the latter will be there. It is no more remarkable than water flowing downhill. What is unusual about the topic at hand is we are accustomed to thinking of the funding currency, the one with the low interest rates, as being in economic trouble. This certainly was the case for the long-running yen carry trade, and later for the Swiss franc and U.S. dollar carry trades

(see “Looking at the carry trade,” “The short, awful life of the dollar carry trade,” and “Franc-ly my dear, I don’t give a carry,” June 2007, August 2008, and September 2008, respectively). What happens when the funding country is the world’s largest holder of foreign reserves, the world’s largest creditor to the United States, and the owner of the highest average annual economic growth rate for the last decade? We are speaking, of course, about China. The Chinese yuan (CNY) has gone through three distinct periods over the past decade. First, it was pegged, much to the consternation of U.S. protectionists, to the FIGURE 1: TWO YUAN SpOT RATES USD until July 21, 2005. It then began a gradual and controlled revaluation until, without public notice, it was re-pegged to the USD over the weekend of July 12-13, 2008—apparently part of a deal to maintain China as an investor in U.S. agency securities. This date will be noted with a green vertical line on all accompanying charts. The third period, noted with a magenta vertical line on all charts, came during mid-June 2009. This was when the total carry return of the USD into the CNY stopped rising. As the currency was pegged, we can infer the interest spread converged to zero at this time. The Chinese had to adopt U.S. interest rates to maintain the peg of the CNY This started to end on May 25, 2010 with a significant flattening of the Before July 2008, the CNY consistently strengthened vs. the USD (declining Chinese money market curve; six-month red line) while the CNY weakened against the EUR (blue line), which means CNY rose relative to nine-month CNY. the USD was weakening significantly against the EUR during this period. After the close of business on June 18,
July 2010 • CURRENCY TRADER

22

2010, the Peoples’ Bank of China announced it would allow for a gradual revaluation of the CNY.

equity market effects

Greenbacks and euros and yuan, oh my
We can illustrate the yuan carry trade with two currency pairs, the USD/CNY and the CNY/EUR. First, let’s take a look at them as spot rates only. Figure 1 illustrates the previously the discussed history; prior to July 2008, the consistent strengthening of the CNY against the USD is quite visible (declining red line). The CNY weakened against the EUR as part of an erratic trend (blue line); by the transitive property of relationships, we can deduce the USD was weakening against the EUR significantly over this period. The effects of the July 2008 re-pegging of the CNY are obvious, especially in light of the rather pronounced volatility of the CNY per EUR rate. Once interest-rate convergence was achieved in June 2009, the CNY began to weaken against the EUR until the latter currency started to feel the ill effects of its various sovereign-credit crises at the end of November 2009. Now let’s restate the two exchange rates not in terms of spot values, but rather in terms of a carry index beginning in September 2005. For simplicity’s sake, the dollar carry into the yuan and the yuan carry into the Euro will be designated as USD:CNY and CNY:EUR. The carry indices combine interest-rate spread returns as well as spot rate gains and losses. The key feature for the USD:CNY is how it flattens after interest-rate convergence (Figure 2). The key feature for the CNY:EUR is how profitable it became between June and November 2009 to borrow the CNY and lend in the EUR. This profitability and a similar profitability for the USD:CNY prior to July 2008 coincided with global bull markets in equities and other risky assets. After both carry trades started to weaken, global markets for risky assets remained stalled until irrefutable evidence the world was not headed back into recession emerged in February 2010.

Let’s demonstrate these relationships by mapping the MSCI total return index for the U.S. against a three-month rolling correlation of returns for this series against those

FIGURE 2: CHINA COULD LEND pROFITABLY IN EUROZONE BEFORE EUROpEAN SOvEREIGN-DEBT WEAKNESS

The profitability of borrowing the CNY and lending in the EUR between June and November 2009, and a similar profitability for the USD:CNY prior to July 2008, coincided with global bull markets in equities and other risky assets.

FIGURE 3: THE USD:CNY CARRY AND U.S. STOCKS

Prior to July 2008, the correlation between USD:CNY carry returns and U.S. stock return was mostly negative. During the late-2008 financial crisis the correlation of returns turned positive as global money fled into the dollar, but by 2010 the overall correlation was weak and unstable once again.

CURRENCY TRADER • July 2010

23

ADVAnCeD stRAteGIes on tHe MoneY

of the USD:CNY (Figure 3). The answer does not jump out at us immediately when we view the chart; prior to July 2008, the correlation of returns is mostly negative. As

American stocks rose (fell), the USD:CNY generally fell (rose). During the financial crisis of late 2008, the correlation of returns turned positive as global money fled into the dollar. By 2010, the overall correlation was weak and unstable once again. It was only after August 24, 2009 that FIGURE 4: THE CNY:EUR CARRY AND EUROZONE STOCKS the impact of the USD:CNY became NOW STRONGLY pOSITIvELY CORRELATED apparent, and here the cause was external. Three-month USD LIBOR fell below three-month JPY LIBOR; it was now cheaper for anyone involved in global carry trades to borrow the USD than to borrow the JPY. This unexpected switch in global funding rates would remain intact until March 2010. As the global supply of USD is much larger than that of JPY, and because the $2.273 trillion foreign exchange reserves of China were linked to USD rates, a sudden source of cheap funding became available for global financial speculation. Global equity markets scarcely experienced a downtick over the next two months. It is in the EUR, however, where the effects of the carry trades really become evident (Figure 4). Shortly after the July Shortly after the July 2008 re-pegging of the yuan to the dollar, correlation 2008 re-pegging, the three-month rollof returns between the MSCI Eurozone index and the CNY:EUR turned and ing correlation of returns between the remained strongly positive regardless of what European equities were doing. MSCI Eurozone index and the CNY:EUR turned and remained strongly positive FIGURE 5: THE USD:CNY CARRY AND U.S. GOvERNMENT BONDS regardless of what European equities were doing. USD rates were well below EUR rates throughout this period, and as China moved toward interest-rate convergence with the U.S., both currencies became funding sources for European (and other) markets.

Fixed-income effects

The correlation of returns between the USD:CNY and U.S. government bonds turned negative after the July 2008 re-pegging of the CNY, and it remained so until February 2010.

If the yuan carry trade effects equities, it should affect fixed-income markets as well. Let’s use the Merrill Lynch total return series for the U.S. and PanEuropean bonds for government bond returns and the ML U.S. Corporate & High-Yield Master and Eurozone 7-10 Year Corporate index for corporate bonds. First, the three-month rolling correlation of returns between the USD:CNY and U.S. government bonds turned negative after the July 2008 re-pegging of the CNY, and it remained negative until
July 2010 • CURRENCY TRADER

24

February 2010 (Figure 5). percent, and the impact between the third and second The picture is different for the U.S. corporate bonds periods was 28.5 percent. The wide carry made European (Figure 6). As investors dumped these bonds during the government bonds attractive. 2008 financial panic, the correlation turned sharply negaWhat about the European corporate bonds? Here we tive. Once the returns on the USD:CNY started to flatten should expect the very wide carry to produce highly sigand investors moved back into corporate bonds in 2009, the correlation again FIGURE 6: THE USD:CNY CARRY AND U.S. CORpORATE BONDS turned negative until February 2010. Figure 7 shows much less negative correlation of returns between the CNY:EUR and Pan-European government bonds. The wider carry allowed funds to flow into the European government bonds and support a huge rally during 2009. That diminished negative and weakly positive correlation of returns is even more apparent when we look at the European corporate bonds (Figure 8). Investors were able to pile into these bonds at a very wide carry, especially after the June 2009 convergence of interest rates. How significant were the shift dates of July 2008 and June 2009 in assessing the impact of the carry trades on fixedincome markets? If we run a series of As investors dumped U.S. corporate bonds during the 2008 financial panic, regressions across the three different perithe correlation turned sharply negative. When the returns on the USD:CNY started to flatten and investors moved back into corporate bonds in 2009, the ods of the form ln(bond) = f(ln(carry)) correlation again turned negative until February 2010. and capture the residuals of each, the results become quite apparent. In Figure 8, each residual set is displayed with the FIGURE 7: THE CNY:EUR CARRY AND pAN-EUROpEAN pre-July 2008 period in turquoise, the GOvERNMENT BONDS revaluation period in green and the postJune 2009 period in magenta. The shift in regime did not exert a significant change on the relationship between the USD: CNY and U.S. government bonds. We can be confident the third period, the interest rate convergence period, was different from the combined previous two periods and the second period at 5.6 percent and 0.8-percent confidence only. The answer is markedly different for the U.S. corporate bonds; here the respective confidence levels are 99.8 percent and 95.4 percent. We can conclude the convergence of interest rates for the yuan carry trade affected risk-taking behavior positively and risk-averting behavior not at all. Now let’s shift to the CNY:EUR cases (Figure 9). Here the impact of interestFigure 7 shows much less negative correlation of returns between the CNY: rate convergence for the third period EUR and Pan-European government bonds than between the USD:CNY carry with respect to the combined previous and U.S. government bonds. two periods was a highly significant 95.2
CURRENCY TRADER • July 2010 25

ADVAnCeD stRAteGIes

FIGURE 8: THE CNY:EUR CARRY AND EUROZONE 7-10 YEAR CORpORATE BONDS

The diminished negative and weakly positive correlation of returns from Figure 7 is even more pronounced in the case of European corporate bonds.

nificant changes in behavior, and this is exactly the case. The third period is different from both the combined first two periods and the second period alone at near-100 percent confidence. We have to conclude on both the stock and the bond cases that the opening of the yuan carry trade after interest-rate convergence in June 2009 led to a liquidity-fueled bull market around the world. Of course, liquidity, like tides, can flow out as well as in, and any ending of the interest-rate convergence accompanied by an increase in U.S. short-term interest rates (note to younger traders: U.S. short-term interest rates can and do rise) will pose an extreme threat to the global financial markets. ›
For information on the author, see p. 4.

FIGURE 9: U.S. CORpORATE AND GOvERNMENT BONDS

FIGURE 10: EUROZONE CORpORATE AND GOvERNMENT BONDS

The shift in regime did not exert a significant change on the relationship between the USD:CNY and U.S. government bonds (bottom), but in the case of U.S. corporate bonds (top), the convergence of interest rates for the yuan carry trade affected risk-taking behavior positively and risk-averting behavior not at all.
26

A wide carry made European government bonds (top) attractive, and produced highly significant changes in behavior in the case of European corporate bonds (bottom).

July 2010 • CURRENCY TRADER

CURRenCY FUtURes snAPsHot

as of 6/25/10

The information does noT constitute trade signals. it is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields. note: average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable).

Market eUR/UsD JPY/UsD AUD/UsD GbP/UsD CAD/UsD CHF/UsD MXn/UsD U.s. dollar index nZD/UsD e-Mini eUR/UsD

Sym eC JY AD bP CD sF MP DX ne Ze

Exch CMe CMe CMe CMe CMe CMe CMe ICe CMe CMe

vol 377.4 143.0 125.2 125.1 95.7 51.7 26.5 23.8 9.0 6.3

OI 241.4 111.8 82.8 128.3 94.3 44.9 68.7 31.0 14.7 4.9

10-day move / rank 0.33% / 10% 2.38% / 92% 1.53% / 31% 2.27% / 75% -0.41% / 0% 4.86% / 93% 0.13% / 6% -1.01% / 30% 1.73% / 21% 0.33% / 10%

20-day move / rank -0.26% / 2% 1.67% / 50% 2.45% / 75% 4.28% / 100% 1.56% / 45% 6.46% / 100% 1.00% / 22% -0.86% / 58% 4.12% / 80% -0.26% / 2%

60-day move / rank -8.85% / 78% 6.01% / 100% -5.15% / 64% -0.52% / 3% -2.37% / 73% -2.09% / 20% -3.13% / 97% 5.74% / 58% 0.37% / 21% -8.85% / 78%

volatility ratio / rank .06 / 0% .48 / 62% .14 / 0% .31 / 72% .33 / 35% .38 / 55% .19 / 13% .09 / 0% .40 / 33% .06 / 0%

note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.

lEgEnd: Volume: 30-day average daily volume, in thousands. oi: 30-day open interest, in thousands. 10-day move: The percentage price move from the close 10 days ago to today’s close. 20-day move: The percentage price move from the close 20 days ago to today’s close. 60-day move: The percentage price move from the close 60 days ago to today’s close. The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the percentile rank of the most recent move to a certain number of the previous moves of the same size and in the same direction. for example, the % rank for the 10-day move shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, it shows how the most recent 20-day move compares to the past sixty 20-day moves; for the 60-day move, it shows how the most recent 60-day move compares to the past one-hundred-twenty 60-day moves. a reading of 100% means the current reading is larger than all the past readings, while a reading of 0% means the current reading is smaller than the previous readings. Volatility ratio/% rank: The ratio is the shortterm volatility (10-day standard deviation of prices) divided by the long-term volatility (100-day standard deviation of prices). The % rank is the percentile rank of the volatility ratio over the past 60 days.

BarclayHedge Rankings for May 2010
Top 10 currency traders managing more than $10 million as of 05/31/10, ranked by May 2010 return Trading Advisor 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Dacharan Capital (High exposure) InsCH Capital Mgmt (Kintillo X3) Friedberg Comm. Mgmt. (Curr.) 24FX Management Ltd Hathersage (Long term Currency) First Quadrant (Managed Currency) Richmond Group (Gl. Currency) IPM Global Currency Fund (C) IKos FX Fund Hathersage (Daily Currency) May Return 26.81% 12.81% 11.91% 11.67% 9.67% 9.62% 8.49% 7.89% 6.82% 4.11% 2010 YTD Return 42.49% 3.59% 33.41% 16.51% 6.23% 11.47% 1.36% 8.75% 17.43% 5.10% $ Under Mgmt. (Millions) 10.0 54.3 78.7 28.4 425.0 517.0 37.0 168.0 684.0 100.0

Top 10 currency traders managing less than $10M & more than $1M as of 05/31/10, ranked by May 2010 return 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. D2W Capital Mgmt (Radical Wealth) Vaskas Capital Mgmt (Global FX) Aurora Futures Corp (FX) blue Fin Capital (Managed Currency) Capricorn Advisory Mgmt (FXG10) Millennium Global Currency (UsD) Analytic Invest. Mgmt (AsC enhanced) M2 Global Mgmt (2.5X) Quant trading (FX Quant 11) trident Asset Mgmt. (Gl. Currency) 14.80% 10.06% 5.20% 3.38% 2.37% 2.05% 1.29% 0.62% 0.58% 0.38% 48.68% -10.52% 3.88% 3.29% 3.80% -0.97% 0.81% 3.54% -3.00% 0.60% 1.8 3.3 2.5 3.4 8.6 2.4 4.9 2.5 4.5 7.0

Based on estimates of the composite of all accounts or the fully funded subset method. Does not reflect the performance of any single account. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

CURRENCY TRADER • July 2010

27

InteRnAtIonAL MARKets
CURRENCIES (vs. U.S. DOLLAR)
Rank Currency 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 new Zealand dollar swiss franc Australian dollar british pound brazilian real south African rand Canadian dollar swedish krona singapore dollar Japanese yen Indian rupee Chinese yuan Hong Kong dollar thai baht taiwanese dollar Russian ruble euro June 25 price vs. U.S. dollar 0.708365 0.90633 0.86945 1.49667 0.5595 0.13175 0.960185 0.12871 0.71888 0.01117 0.02155 0.14699 0.128565 0.030875 0.031215 0.03219 1.231785 1-month gain/loss 5.12% 4.83% 4.71% 3.69% 3.68% 3.20% 1.67% 1.19% 1.11% 0.90% 0.89% 0.38% 0.30% 0.18% 0.18% -0.12% -0.82% 3-month gain/loss 0.83% -3.17% -4.63% 0.25% -0.06% -2.90% -1.85% -6.66% 0.98% 2.24% -2.13% 0.35% -0.22% 0.05% -0.59% -4.54% -7.83% 6-month gain/loss 1.05% -5.25% -0.89% -6.21% -0.80% 1.21% 1.17% -5.92% 1.34% 2.38% 1.08% 0.37% -0.30% 2.88% 1.02% -2.38% -13.73% 52-week high 0.7635 1.0087 0.9405 1.7042 0.5882 0.1389 1.0068 0.148 0.7326 0.01179 0.02263 0.14760 0.129 0.03157 0.03201 0.03497 1.5144 52-week low 0.6194 0.853 0.7723 1.4235 0.4844 0.12 0.8527 0.1227 0.6817 0.01023 0.01988 0.1458 0.1281 0.0289 0.03007 0.03007 1.1891 previous 13 14 17 10 7 9 11 16 6 1 8 2 3 4 5 12 15

gLObAL CENtRAL bANk LENDINg RAtES
Country United states Japan eurozone england Canada switzerland Australia new Zealand brazil Korea taiwan India south Africa Interest Rate Fed funds rate overnight call rate Refi rate Repo rate overnight funding rate 3-month swiss Libor Cash rate Cash rate selic rate overnight call rate Discount rate Repo rate Repurchase rate Rate 0-0.25 0.1 1 0.5 0.5 0.25 4.5 2.75 9.5 2 1.25 5 6.5 Last change 0.5 (Dec. 08) 0.2 (Dec. 08) 0.25 (May 09) 0.5 (March 09) 0.25 (June 10) 0.25 (March 09) 0.25 (May 10) 0.25 (June 10) 0.75 (April 10) 0.5 (Feb. 09) 0.25 (Feb. 09) 0.25 (April 10) 0.5 (Mar. 10) Dec-09 0-0.25 0.1 1 0.5 0.25 0.25 3.75 2.5 8.75 2 1.25 4.75 7 Jun-09 0-0.25 0.1 1 0.5 0.25 0.25 3 2.5 9.25 2 1.25 4.75 7.5

GLOBAL STOCK INDICES Country 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 India brazil Hong Kong Italy singapore Germany Mexico France south Africa Australia switzerland Japan UK Canada U.s. Index bse 30 bovespa Hang seng Ftse MIb straits times Xetra Dax IPC CAC 40 Ftse/Jse All share All ordinaries swiss Market nikkei 225 Ftse 100 s&P/tsX composite s&P 500 June 25 17,574.53 64,824.00 20,690.79 19,961.74 2,851.64 6,070.60 32,607.13 3,519.73 27,258.07 4,439.40 6,275.40 9,737.48 5,046.50 11,707.85 1,076.76 1-month gain/loss 9.69% 9.53% 8.98% 8.59% 7.58% 7.06% 6.44% 5.66% 4.12% 3.57% 3.02% 2.93% 2.14% 1.65% 0.00% 3-month gain/loss 0.09% -5.29% -0.42% -13.34% -1.27% -1.02% -1.68% -12.02% -4.54% -9.33% -8.98% -10.08% -11.89% -2.09% -7.63% 6-month gain loss 1.23% -4.53% -3.84% -14.34% 0.49% 1.13% 0.18% -10.04% -1.17% -7.58% -4.63% -7.59% -6.59% -0.40% -4.41% 52-week high 18,047.90 71,989.00 23,099.60 24,559 3,037.97 6,341.52 34,223.90 4,088.18 29,565.10 5,048.60 6,990.70 11,408.20 5,833.70 12,321.80 1,219.80 52-week low 13,220.00 48,262.00 17,186.00 17,626 2,226.10 4,524.01 23,033.90 2,957.83 21,665.90 3,710.10 5,204.80 9,050.33 4,096.10 9,535.50 869.32 previous 3 12 8 15 7 5 2 14 4 9 6 13 11 1 10

28

July 2010 • CURRENCY TRADER

NON-U.S. DOLLAR fOREx CROSS RAtES
Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Currency pair new Zeal $ / Yen Franc / Yen Aussie $ / Yen Franc / Canada $ Aussie $ / Canada $ Pound / Yen Pound / Canada $ Aussie $ / Real Canada $ / Yen Aussie $ / Franc Aussie $ / new Zeal $ Pound / Aussie $ Pound / Franc euro / Yen Canada $ / Yen euro / Canada $ Yen / Real euro / Pound euro / Real euro / Aussie $ euro / Franc Symbol nZD/JPY CHF/JPY AUD/JPY CHF/CAD AUD/CAD GbP/JPY GbP/CAD AUD/bRL CAD/JPY AUD/CHF AUD/nZD GbP/AUD GbP/CHF eUR/JPY CAD/bRL eUR/CAD JPY/bRL eUR/GbP eUR/bRL eUR/AUD eUR/CHF June 25 63.425 81.15 77.85 0.943915 0.90551 134.05 1.558735 1.55399 85.97 0.959315 1.22737 1.721395 1.65136 110.29 1.716155 1.282865 0.01996 0.823015 2.201595 1.41675 1.359095 1-month gain/loss 4.21% 3.94% 3.81% 3.12% 2.99% 2.81% 1.99% 0.96% 0.79% -0.12% -0.39% -0.97% -1.09% -1.67% -1.98% -2.45% -2.75% -4.35% -4.38% -5.29% -5.40% 3-month gain/loss -1.38% -5.28% -6.69% -1.34% -2.83% -1.87% 2.14% -4.58% -4.00% -1.51% -5.41% 5.12% 3.52% -9.84% -1.79% -6.09% 2.28% -8.05% -7.77% -3.35% -4.81% 6-month gain loss -1.32% -7.47% -3.21% -6.35% -2.04% -8.39% -7.30% -0.09% -1.21% 4.60% -1.93% -5.37% -1.01% -15.75% 1.98% -14.73% 3.23% -8.02% -13.04% -12.96% -8.95% 52-week high 69.5573 91.549 88.048 1.0724 0.9895 163.057 1.9173 1.6978 94.1955 1.0079 1.3233 2.0859 1.8112 138.715 1.8244 1.63 0.02227 0.9411 2.8724 1.8005 1.5383 52-week low 58.1679 76.36 46.508 0.8989 0.8643 127.065 1.4894 1.5256 79.6163 0.8457 1.1931 1.6328 1.5778 108.31 1.6003 1.2502 0.01838 0.8179 2.1772 1.377 1.3542 previous 18 19 21 6 14 16 5 15 17 12 13 2 4 20 8 9 1 10 11 3 7

ACCOUNt bALANCE
Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Country singapore norway Hong Kong sAR sweden Germany taiwan Province of China netherlands Japan switzerland Canada Korea United Kingdom belgium Czech Republic Italy Australia United states Ireland spain 2008 36.188 83.825 29.296 37.279 245.722 25.122 41.978 157.079 11.947 7.606 -5.776 -40.725 -12.855 -6.669 -78.874 -46.683 -706.068 -13.886 -153.665 Ratio* 19.222 18.59 13.618 7.783 6.69 6.239 4.787 3.214 2.388 0.507 -0.62 -1.517 -2.539 -3.086 -3.418 -4.406 -4.889 -5.189 -9.592 2007 47.311 54.678 25.529 39.054 253.756 32.975 67.589 210.967 43.531 14.53 5.876 -75.483 9.956 -5.483 -51.691 -57.552 -726.572 -13.876 -144.435 2009+ 33.838 52.901 23.373 25.781 160.627 42.572 41.652 141.656 43.102 -36.132 42.668 -28.838 -1.254 -1.942 -71.27 -40.941 -417.999 -6.705 -74.136
Totals in billions of u.S. dollars *account balance as percent of gdP +Estimate Source: International Monetary Fund, World Economic Outlook Database, april 2010.

gLObAL bOND RAtES
Rank 1 2 3 4 5 Country U.s. Germany Japan Australia UK Rate 10-year t-note bUnD Government bond 10-year bonds short sterling June 25 121.48 128.98 141.08 94.73 99.16 1 month 4.20% 3.97% 0.11% -0.01% -0.06% 3 months 3.33% 4.97% 1.89% 0.54% -0.14% 6 months 4.98% 5.82% 0.94% 0.45% -0.15% High 122.56 129.93 143.28 94.87 99.52 Low 114.78 119.85 136.94 94.09 98.90 previous 3 1 5 4 2
29

CURRENCY TRADER • July 2010

InteRnAtIonAL MARKets
Unemployment AMERICAS EUROpE Argentina brazil Canada France Germany UK Australia Hong Kong India Japan singapore Argentina brazil Canada France Germany UK s. Africa Australia Hong Kong India Japan singapore period Release date Rate Change 1-year change Next release

ASIA and S. pACIFIC GDp AMERICAS EUROpE AFRICA ASIA and S. pACIFIC

Q1 May May Q1 May Feb.-April May March-May May Q1 Q1
period

5/21 6/24 6/4 6/3 6/30 6/16 6/16 6/17 6/29 4/30 4/30 6/18 6/8 5/31 5/12 5/12 3/30 5/24 6/2 5/14 5/31 5/20 5/21

8.3% 7.5% 8.1% 9.5% 7.0% 7.9% 5.3% 4.6% 5.2% 2.2% 2.2% -0.6% -2.7% 2.5% 0.4% 0.6% 1.2% 2.2% 0.6% -6.5% 19.1% 1.2% 4.1% -0.8% 0.4% 0.3% 0.1% 0.1% 0.2% 0.2% 0.9% 0.3% 1.2% 0.1% 0.6%

-0.1% 0.2% 0.0% 0.0% -0.1% 0.1% 0.1% 0.2% 0.1% -0.1% -0.1%

-0.1% -1.3% -0.4% 0.8% -0.6% 2.6% -0.2% -0.7% 0.1% -1.0% -0.1%

8/23 7/22 7/9 9/2 7/29 7/14 7/8 7/20 7/30 7/30 7/30

Q1 Q1 Q1 Q1 Q1 Q4 Q1 Q1 Q1 Q1 Q1 Q1

Release date

Change

1-year change

14.8% 15.2% 5.6% 0.7% 3.2% -1.7% -4.7% 2.7% 9.2% 12.2% 4.9% 15.5%

Next release

9/17 9/3 8/31 8/13 8/13 7/12 8/24 9/1 8/13 8/31 8/16 nLt 8/27 7/14 7/7 7/23 7/13 7/9 7/13 7/28 7/28 7/22 7/30 7/30 7/23

CpI AMERICAS EUROpE AFRICA ASIA and S. pACIFIC Argentina brazil Canada France Germany UK s. Africa Australia Hong Kong India Japan singapore Argentina brazil Canada France Germany UK s. Africa Australia Hong Kong India Japan singapore

period

Release date

Change

1-year change

Next release

May May May May May May May Q1 May May May May
period

6/11 6/9 6/22 6/11 6/10 6/15 6/23 4/28 6/22 6/30 6/25 6/23
Release date

10.7% 5.2% 1.4% 1.6% 1.2% 3.4% 4.6% 2.9% 2.5% 13.9% -0.9% 3.2%
1-year change

ppI AMERICAS EUROpE AFRICA ASIA and S. pACIFIC

Change

Next release

May May May May May May May Q1 Q2 May May May

6/11 6/9 6/29 7/1 6/24 6/11 6/24 4/27 6/14 6/10 6/10 6/29

1.0% 2.2% 0.3% 0.1% 0.3% 0.3% 0.1% 1.0% 1.7% 1.7% 0.1% -2.0%

15.2% 0.5`% 1.4% 3.8% 0.9% 5.7% 6.8% -0.1% 4.0% 10.2% 0.4% 7.9%

9/3 7/7 7/29 7/30 7/20 7/9 7/29 7/26 9/13 7/14 7/12 7/29

as of June, 30 2010

lEgEnd: Change: Change from previous report release. nlT: no later than. rate: unemployment rate.

30

July 2010 • CURRENCY TRADER

GLobAL eConoMIC CALenDAR: JULY
CPI: Consumer price index eCb: european Central bank FDD (first delivery day): the first day on which delivery of a commodity in fulfillment of a futures contract can take place. FnD (first notice day): Also known as first intent day, this is the first day on which a clearinghouse can give notice to a buyer of a futures contract that it intends to deliver a commodity in fulfillment of a futures contract. the clearinghouse also informs the seller. FoMC: Federal open Market Committee GDP: Gross domestic product IsM: Institute for supply management LtD (last trading day): the final day trading can take place in a futures or options contract. PMI: Purchasing managers index PPI: Producer price index economic release (U.s.) gdP CPi ECi PPi iSM unemployment Personal income durable goods retail sales Trade balance leading indicators Release time (et) 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m.

July 1 France: May PPI 2 U.S.: June employment report 3 4 5 6 U.S.: June IsM report 7 Brazil: June CPI and PPI 8 Australia: June employment report
Mexico: June 30 CPI and June PPI UK: bank of england interest-rate announcement ECB: Governing council interestrate announcement

21 22

U.S.: June leading indicators Brazil: June employment report Hong Kong: June CPI Mexico: July 15 CPI

23 24 25 26 27 28

Canada: June CPI Mexico: June employment report

Australia: Q2 PPI U.S.: Fed beige book and June durable orders Australia: Q2 CPI South Africa: June CPI

9

Canada: June employment reportGermany: June CPI UK: June PPI

29

Canada: June PPI France: June PPI Germany: June employment report South Africa: June PPI

10 11 12 13

Japan: June PPI U.S.: May trade balance France: June CPI UK: June CPI

30

U.S.: Q2 GDP (advance) and eCI Japan: June employment report and CPI

31 august 1 2 U.S.: July IsM report 3 U.S.: June personal income 4 5 UK: bank of england interest-rate
announcement ECB: Governing council interest-rate announcement

14

U.S.: June retail sales India: June PPI Japan: bank of Japan interest-rate announcement UK:May employment report

July 2010 30 31 6 7 1 8 2 9 3 4 5 10 11 12

13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 1 2

15 16 17 18 19 20

U.S.: June PPI U.S.: June CPI

U.S.: June housing starts Canada: bank of Canada interestrate announcement Germany: June PPI Hong Kong: April-June employment report

6

U.S.: July employment report UK: July PPI

the information on this page is subject to change. Currency trader is not responsible for the accuracy of calendar dates beyond press time.

CURRENCY TRADER • July 2010

31

eVents
event: the Moneyshow san Francisco 2010 show focus: Green investing date: Aug. 19-21 location: san Francisco Marriott For more information: Go to www.moneyshow.com and click on events > the World Moneyshows event: the Cboe options Intensive dates: Aug. 26, oct. 21 location: Chicago For more information: Go to www.cboe.com and click on education > seminars event: Fifth annual free Paris trading show date: sept. 17-18 location: Paris For more information: www.salonAt.com event: security traders Association 77th annual conference and business meeting date: sept. 22-25 location: Washington D.C. For more information: www.securitytraders.org event: Cboe Real trading with Dan sheridan date: sept. 23 location: Chicago For more information: Go to www.cboe.com and click on education > seminars event: the Forex, Futures & etFs expo Las Vegas 2010 date: sept. 23-25 location: Caesars Palace, Las Vegas For more information: Go to www.moneyshow.com event: seC Customer Protection Rule one-day seminar date: sept. 29 location: bayards, new York City For more information: www.fmwonline.com event: Las Vegas traders expo date: nov. 17-20 location: Caesars Palace, Las Vegas For more information: Go to www.moneyshow.com event: 2010 sydney trading & Investing seminars & expo date: oct. 29-30 location: sydney For more information: www.tradingandinvestingexpo.com.au event: FXstreet.com International traders Conference date: oct. 20-22 location: barcelona, spain For more information: www.traders-conference.com event: CMe Group’s Global Financial Leadership Conference date: oct. 18-20 location: Ritz-Carlton beach Resort, naples, Fla. For more information: www.gflc.com event: the First Qatar traders expo date: oct. 17-18 location: J.W. Marriott, Qatar For more information: www.metradersexpo.com event: the third Kuwait traders expo date: oct. 13-14 location: J.W. Marriott, Kuwait City For more information: www.metradersexpo.com

KeY ConCePts
Carry trades involve buying (or lending) a currency with a high interest rate and selling (or borrowing) a currency with a low interest rate. Traders looking to “earn carry” will buy a high-yielding currency while simultaneously selling a low-yielding currency.›

32

July 2010 • CURRENCY TRADER

neW PRoDUCts

interactive brokers (www.interactivebrokers.com) has enhanced its ScaleTrader algorithm to include pairs trading, enabling clients to trade the spread between any two securities. Investors typically buy the shares of one company and sell those in another when the distance between the two prices moves towards an extreme value and away from an observed relationship. The Interactive Brokers ScaleTrader algorithm allows clients to create conditions under which a long position in one stock is built while simultaneously creating an offsetting short position in the other. The ScaleTrader is named because investors can “scale-in” to market weakness by setting orders to buy as the market moves lower. Similarly, sell orders can be “scaled” into when a market is rising. The ScaleTrader algorithm can be programmed to buy the spread and subsequently take profit by selling the spread if the difference reaches predetermined levels set by the user. Orders can be entered using net share price differences or by using credit or debit ratios. Investors can set their own parameters to determine the starting number of shares and maximum size of the position they wish to create, and must determine the distance between each incremental buying price. In addition the user may vary the increment over time. The ScaleTrader Pair Trading algorithm is available to all Interactive Brokers customers through its Trader Workstation trading software at no additional charge. e*trade securities has launched an open application programming interface (“Open API”) for third-party and independent software developers to integrate seamlessly with E*TRADE’s investing platform. Through the new Open API, customers will have access to technical information and documentation, reference guides, and other resources to help integrate external applications and programs with E*TRADE’s investing platform. E*TRADE also announced plans to integrate with third-party vendors, including CoolTrade and AbleSys, offering investors seamless integration between E*TRADE’s trading technology, and the market research and stock trading tools of external programs. CQG, inc. (www.cqg.com) has expanded its fixedincome news coverage by adding a new product, MNI Fixed Income Select, from real-time news agency Market News International (MNI). MNI Fixed Income Select will offer original running commentary on global fixed-income markets, presented in bullet-point format. MNI’s reporting and commentary includes live coverage from Chicago’s futures exchanges. The bollinger on bollinger bands Web site (www.BollingerOnBollingerBands.com) finished a complete upgrade in late June. New features include John Bollinger’s latest work and Bollinger Band tools unique to the Web site: BB Impulse, which measures price moves as a function of the width of the Bollinger Bands; Percent
CURRENCY TRADER • July 2010

Bandwidth, which is a normalized and more intuitive view of BandWidth; Bandwidth Delta, which charts the rate of change in BandWidth. Also included are three indicators developed by Jim Alphier: Alphier Conviction, which is a divergence indicator that compares the count of plus and minus days vs. actual gains; Alphier Expectation, which is a supply-demand chart with specific buy and sell rules; Alphier Psychology, which is the central component of the Alphier Expectation chart that is more sensitive and shorter-term in outlook. New Chart Overlays include: the Price Magnet, which is an overly that plots a series of points in and around the price structure that provide an indication of potential price movement; Bollinger Envelopes, which are a variation on Bollinger Bands that focus on the extremes of price action. Bollinger Bands are centered on a moving average (usually of the closing price), while Bollinger Envelopes are anchored by the extremes (highs and the lows). Worden brothers inc., (www.wordenbrothers. com) provider of stock-market analysis tools, including FreeStockCharts.com, announced its technological suite of real-time charts was chosen by QUODD Financial Information Services to be used in its full-featured platform. Worden’s Web-based widgets deliver streaming, real-time stock data to any browser and can be crafted to fit into many applications. Worden’s retail products include TeleChart, StockFinder, and FreeStockCharts.com, as well as educational materials published in books, newsletters, videos and live nationwide training classes. the active trader magazine Group (www.activetradermag.com) has launched a new digital magazine, Managed Futures Today, dedicated to the professionally managed futures industry. This free magazine, which will initially be published quarterly, covers investing and trading concepts, risk management, and industry news for investment advisors and individual investors seeking to integrate managed futures into their long-term, diversified investment portfolios. To see the current issue, go to www.managedfuturestodaymag.com. alpari (US), a leading provider of online forex trading services and technology, has announced the launch of a free live audio market commentary service for its clients, launched in conjunction with Alpari (UK) and its subsidiaries. “Alpari Squawk” is a dedicated audio stream that covers major market-moving stories throughout the trading day, including coverage of economic news and figures as they are released, such as fixed-income, interest rates, equities, FX and commodities. First Call, a team of professional market analysts, manages the service. Alpari clients are able to access Squawk via the Alpari Web site: https://my.alpari-us.com/en/squawk/ from 7:15 a.m.4:15 p.m. ET, Monday through Friday.›

33

FoReX tRADe JoURnAL
Testing out a scalp setup.
trade
date: Monday, June 28, 2010 (1:50 p.m.). entry: Short the Euro/U.S. dollar pair (EUR/USD) at 1.2294. reason for trade/setup: The trade was based on one of the signals from “Five-minute forex scalp.” Monitoring different variations of the two setups presented a short opportunity around 1:50 p.m. CT. After two consecutive five-minute bars that closed in the upper 25 percent of their ranges, a limit order was entered .0004 above the high of the second bar. The next five-minute bar extended only 3 pips higher, so the trade was executed at the next bar. We look for a quick 10pip profit, and will risk 10 pips to the upside. initial stop: 1.2304. initial target: 1.2280.
source: tradestation

outcome: After an initial drop to 1.2285, the market rebounded to the entry price over the next 15 minutes. We simply decided to cover at 1.2290 because this was an “exploratory” trade designed to test out the pattern setup, and the more favorable patterns we analyzed often appeared to hit their targets within the first few bars (maxing out around six or seven bars after entry). Price dropped to the target three bars later and, after one more upside bounce, fell another 10 pips by 3 p.m. Despite not capitalizing fully on the trade, it was gratifying to see this pattern perform as expected in real-time, as did two more setups the next morning. ›

result
exit: 1.2290. Profit/loss: .0004

Note: Initial trade targets are typically based on things such as the historical performance of a price pattern or a trading system signal. However, because individual trades are dictated by immediate circumstances, price targets are flexible and are often used as points at which to liquidate a portion of a trade to reduce exposure. As a result, initial (pre-trade) reward-risk ratios are conjectural by nature.

Trade Summary Date 6/28/10 Currency pair eUR/UsD Entry price 1.2294 Initial stop 1.2304 Initial target 1.2280 IRR 1.00 Exit 1.2288 Date 6/28/10 p/L point .0004 % LOp .0010 LOL Trade length 25 min

Legend: IRR: initial reward/risk ratio (initial target amount/initial stop amount). LoP: largest open profit (maximum available profit during lifetime of trade). LoL: largest open loss (maximum potential loss during life of trade).

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July 2010 • CURRENCY TRADER